Oil prices and the recession

Economist James Hamilton crunched some numbers and found that the current recession can largely be explained by sub-prime mortgagesfinancial derivativesimploding credit marketsinsolvent bankswinged monkeys the surge in oil prices in 2007 and 2008. It’s a result so unexpected that even Hamilton claims not to believe it entirely, but perhaps we shouldn’t be so surprised. Previous oil shocks in 1973, 1979, and 2000 were all followed by recessions.

The Wall Street Journal weaves the finding into a sort of grand unified theory of the financial crisis:

Maybe what happened to oil prices had something to do with credit markets seizing up. The housing bubble saw people of lesser means traveling further afield to buy homes. That gave them long commutes that they were able to afford when gas was $2 a gallon, but maybe they couldn’t at $3. Housing in the exurbs got hit hardest, and one reason why is that high gasoline prices made it hard for people to lived in them to keep up with their mortgage payments, and hard for them to sell their homes without taking a steep loss. In some meaningful way, that has to have contributed to mortgage problems.

Other, more complicated theories have been offered. It’s surprisingly difficult to to ascertain the causes of a recession, and I can’t stress enough that Hamilton’s paper is in no way conclusive. In fact, the current financial crisis was almost certainly sparked by an interlocking set of problems.

But it’s worth pulling these threads, because the implications for energy and environmental policy are stark. Environmental considerations aside, we may not want to couple our prosperity to a volatile commodity whose price is only expected to rise in the long term. Matt Yglesias makes this point about as well as it can be made:

Today’s economy is built on the idea that the atmosphere can safely absorb ever-increasing levels of carbon dioxide, and that ever-increasing quantities of cheap oil can be extracted from underground. Neither, however, is true.